IRS assaults on FLPs.

• Author: Kelm, Jeffrey N.
• Position: Family limited partnerships

The IRS has increased its attack on the use of family limited partnerships (FLPs) as an estate and gift tax planning tool. Despite these attacks, FLPs continue to be a popular tool for transfer tax planning purposes. An FLP allows a taxpayer to maintain control over property transferred to it, while mitigating the transfer tax consequences normally associated with such transfers.

In a typical FLP, a taxpayer transfers property to a limited partnership in exchange for general and limited partnership interests. For valuation purposes, the fair market value (FMV) of a limited partnership interest in the FLP is usually less than the FMV of the interest's pro rata value of the FLP's underlying assets. This is primarily a result of the significant legal restrictions on the limited partner's right to participate in management, transfer the partnership interest or compel the FLP's liquidation. Another major factor requiring a valuation discount is the lack of a ready market for the partnership interests.

The IRS consistently contends that no discounts are allowable in determining the FMV of FLP interests, arguing that the creation of the FLP is a sham that should be ignored for transfer tax purposes. In addition, the Service contends that Chapter 14 of the Internal Revenue Code allows it to disregard the FLP for valuation purposes.

Letter Ruling (TAM) 9719006 clearly illustrates these arguments. In the ruling, the taxpayer formed an FLP two days before her death and contributed marketable securities and several parcels of real estate to it. At the time, she was terminally ill. Immediately after the formation of the FLP...